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Utility M&A: Buying Time

Buying Time
Fortnightly Magazine - October 2004

their options, and listening carefully to major stakeholders before making any significant moves. "Boards and management teams are being very cautious," Bilicic says. "The message they are delivering to shareholders is that they will work to grow the company, but that they will be very careful stewards of their capital."

Squeezing Synergies

Cost efficiencies are the primary economic driver for utility mergers and acquisitions (M&A). However, not everyone agrees about whether the savings are real.

"Some companies merge on the hope that there will be synergies that result in cost savings, but history has shown they often aren't achievable," says Peter N. Rigby, a director with Standard & Poor's in New York. "With some mergers, years have passed and we are still looking for the cost savings that were promised. The market will be more skeptical about realizing those synergies."

Others, however, argue that most utility mergers have yielded good results. "The data is quite compelling in terms of the savings utilities have realized," says George Bilicic, a managing director with Lazard in New York. "The problem is that if you look at share prices and how companies have performed following mergers, it's hard to determine what factors are affecting those prices."

Additionally, utility mergers by their nature don't generate the kind of impact that mergers between some other types of companies generate-such as media or pharmaceuticals companies. This is due largely to the nature of the business itself, which is, after all, selling a rate-regulated commodity product. Utility mergers are often solid, accretive transactions, but they rarely represent truly transformational propositions.

"M&A certainly will be a vehicle for achieving growth," says Jeffrey Holzschuh, a managing director with Morgan Stanley in New York. "But this is fundamentally an industry that won't achieve high growth rates. Companies will have to squeeze out efficiencies and reduce costs" ().

As a result, utilities probably will never feel the kind of consolidation pressure that companies in some other industries feel. "If a utility doesn't do a merger, it's not like it's marginalized in its market," Bilicic says. "There isn't a lot of the strategic urgency that you see in many other businesses."

At the same time, utility mergers will continue, if only because utilities perceive the strategic and operational advantages of achieving a larger scale. "We're the only country in the world with so many comparatively small utilities," says Doug Dunn, a partner with Milbank, Tweed, Hadley & McCloy in New York. "We will have to see consolidation ... because electricity is such an important component of our [gross national product]. We need to put companies together to increase efficiency, lower costs, and improve reliability."

PRIVATE EQUITY

The New Long-Term Money

In the darkest days of the industry's recent crisis, two beacons appeared and brought utility companies back to the light of day. One was the Federal Reserve, which rolled interest rates back and flooded the economy with cheap debt. The other was the private equity market, which was flush with cash and looking for a good place to invest.

"When Warren Buffett jumped into the